What is a Balance Sheet?

A balance sheet lays out the ending balances in a company's asset, liability, and equity accounts as of the date stated on the report. As such, it provides a picture of what a business owns and owes, as well as how much as been invested in it. The balance sheet is commonly used for a great deal of financial analysis of a business' performance. The balance sheet is one of the key elements in the financial statements, of which the other documents are the income statement and the statement of cash flows. A statement of retained earnings may sometimes be attached.

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The Balance Sheet

The Interpretation of Financial Statements

Formula Used for a Balance Sheet

The information listed on the balance sheet must comply with the formula below, which states that the aggregate amount of all assets on the balance sheet must equal the total of all liabilities and equity on the report. This is known as the accounting equation. The accounting equation is required when using the double entry accounting system.

Total assets = Total liabilities + Equity

Format of the Balance Sheet

The format of the balance sheet is not mandated by accounting standards, but rather by customary usage. The two most common formats are the vertical balance sheet (where all line items are presented down the left side of the page) and the horizontal balance sheet (where asset line items are listed down the first column and liabilities and equity line items are listed in a later column). The vertical format is easier to use when information is being presented for multiple periods.

What is Listed on the Balance Sheet?

The line items to be included in the balance sheet are up to the issuing entity, though common practice typically includes some or all of the following items:

Current Assets:

Cash and cash equivalents
Trade receivables and other receivables
Investments
Inventories
Assets held for sale

Non-Current Assets:

Property, plant, and equipment
Intangible assets
Goodwill

Current Liabilities:

Trade payables and other payables
Accrued expenses
Current tax liabilities
Current portion of long-term debt
Other financial liabilities
Liabilities held for sale

Non-Current Liabilities:

Loans payable
Deferred tax liabilities
Other non-current liabilities

Equity:

Example of a Balance Sheet

An example of a balance sheet appears below. It shows a basic set of line items that a seller of goods is likely to use. A seller of services might not use the inventories line item in its balance sheet.

Domicilio Corporation
Balance Sheet

Current Assets on the Balance Sheet

Within the balance sheet, the items noted below should be classified as current assets. In general, any asset is classified as a current asset when there is a reasonable expectation that the asset will be consumed within the next year, or within the operating cycle of the business. All other assets are to be classified as non-current.

Cash and cash equivalents. This account includes physical cash, checking accounts, and short-term investments that can quickly be converted into cash within three months. It represents the most liquid asset a company holds to cover immediate expenses.
Accounts receivable. This represents money owed to the business by customers for goods or services delivered on credit. It is recorded net of any allowance for doubtful accounts, which estimates potential non-payments.
Inventory. Consists of raw materials, work-in-progress, and finished goods that a company intends to sell. It is valued at the lower of cost or market value, ensuring accurate reflection of potential losses.
Prepaid expenses. These are payments made in advance for goods or services to be received in the future, such as insurance or rent. As the service is used, the prepaid amount is expensed accordingly.
Marketable securities. Short-term investments that can easily be converted into cash, such as stocks, bonds, or treasury bills. They are valued at fair market value and held for trading purposes or liquidity management.
Notes receivable (short-term). Amounts owed to the company from third parties based on formal promissory notes due within one year. It includes interest to be received and is recorded at net realizable value.

These accounts collectively represent assets expected to be converted into cash or used up within one operating cycle, typically a year.

Current Liabilities on the Balance Sheet

Within the balance sheet, the following should be classified as current liabilities:

Payables. This is all trade payables related to the purchase of goods or services from suppliers.
Accrued expenses. This is expenses incurred by the business, for which no supplier invoice has yet been received.
Short-term debt. This is loans for which payment is due within the next year.
Unearned revenue. This is advance payments from customers that have not yet been earned by the company.

In general, a liability is classified as current when there is a reasonable expectation that the liability will come due within the next year, or within the operating cycle of the business. All other liabilities are to be classified as non-current.

Balance Sheet Ratios

Some of the more common ratios that include balance sheet information are:

Accounts receivable collection period (measures the average amount of time required to collect accounts receivable)
Current ratio (compares the total amount of current assets to total current liabilities to see if there is a liquidity problem)
Debt to equity ratio (compares total debt to total equity to see if a business is excessively leveraged)
Inventory turnover (measures the amount of time required to sell off inventory)
Quick ratio (compares the most liquid assets to current liabilities, to see if a business can support its immediate obligations)
Return on net assets (measures the income generated on a company’s asset base; this is a measure of asset efficiency)
Working capital turnover ratio (compares the working capital investment to sales, to see if working capital is being used efficiently)

Many of these ratios are used by creditors and lenders to determine whether they should extend credit to a business, or perhaps withdraw existing credit.